NEW YORK (MainStreet ) — The last time we saw interest rates begin to rise, hardly anybody had a Facebook account. It had just been launched. There was no Twitter. Friends had just aired its last episode. From June 2004 until the same month in 2006, the Federal Reserve punched up interest rates 17 times. Since then, rates have tumbled back to the basement. For some time now, economists have cried wolf about the return of rising interest rates, but the Fed is finally hinting just such a move may be sooner rather than later. Here’s what that will mean to you.
Hitting close to home
The biggest impact of higher interest rates will likely hit close to home for consumers: their mortgage. Conventional 30-year mortgages key off of long-term rates from the U.S. Treasury market. When Treasury rates go up, mortgage rates can move with them. But Russ Koesterich, chief investment strategist with BlackRock. is not looking for rates to rocket, but crawl.
“We're not expecting a particularly large backup in rates, and I think that's the most important point — call that somewhere between maybe 15 to 75 basis points,” Koesterich says. “Which still means interest rates, even if we're right, will end the year lower than they were at the end of 2013.”
That slow pace projection is echoed by Indraneel Karlekar, managing director for global research at Principal Real Estate Investors. Karlekar sees a snail’s pace climb in rates – with a favorable impact on commercial real estate.
“Like other risk assets, commercial real estate has been a key beneficiary of the Fed’s ultra-accommodative monetary policy. The downward revision in interest rate expectations suggests that the capital market tailwinds that have been so beneficial to commercial real estate may still have some room to run,” Karlekar wrote in a recent research note.
Little demand for loans
Why are interest rates so low – and what’s keeping them there? There's simply not much demand for money. Consumers are not borrowing the way they did 10 or 20 years ago, whether you look at the housing market or other consumer loans .
The Federal Reserve Bank of New York reported last week that there has been little change in credit application rates over the past 12 months, while credit rejection rates have declined. The
credit market is easing, but demand hasn’t followed. That may be changing. Consumers surveyed by the Fed expressed a likelihood of applying for credit over the next 12 months — particularly in mortgage refinancing.
“The other driver is that we have this very unusual condition, nothing that any of us have seen in our lifetimes, where the central bank, the Fed, has basically anchored short-term rates at zero — and has kept them there for years,” Koesterich adds.
But higher interest rates, even if rising at a glacial pace, will eventually affect our pocketbooks — with rates creeping up on mortgages, credit cards and car loans.
Income investors would welcome a boost in rates for savings accounts, money market funds and certificates of deposit, but don't look for big gains here, either. With savings accounts currently paying under 0.5%, we could be years away from seeing meaningful returns.
“We think the Fed is going to take their time, and for older individuals who are dependent upon income or for anyone who is looking to get a return on their money, it's still going to be an environment where most instruments are paying a very, very low rate,” Koesterich says.
The central bank is targeting a fed funds rate near 3.75%, but Janus Funds bond expert Bill Gross thinks a neutral rate, in which the economy is neither "too hot" or "too cold," might be somewhere closer to 2%. That's a long, slow climb from what has been essentially zero.
"The Fed has to be very careful. They have to take their time — three or four years — in terms of reaching that ultimate rate," Gross told CNBC on Wednesday.
And as rates rise, bond prices fall. On the other hand, yields rise. Investors who hold an individual bond to maturity won’t necessarily need to worry about what happens in the meantime, but bond mutual funds will likely see some losses along the way.
What about the stock market?
Corporate America has been the benefactor of low rates for some time. With the cheap cost of borrowing combined with slow wage growth, U.S. companies have never been more profitable. The result: a booming stock market. It's been an unusually smooth ride for the past two to three years. Going forward, it may be a bit bumpier .